Regulation contemplation

What is your current approach to regulatory matters?

Jensen: We’re registered as an investment adviser in the US and we have been since 1991. We also have offices in other countries. Today we’re regulated in the UK by the FSA, and in France by the AMF and we may eventually have licenses in other countries as we grow our operations. 

Being a registered investment adviser imposes a couple of requirements on us: a periodic reporting requirement, and a set of regulations around the firm’s communications and fund administration activities. We have a pretty comprehensive compliance programme that supports those requirements. We maintain a compliance manual based on the SEC regulations, and each manager in our operations is responsible for maintaining their section of that compliance manual and making sure that we follow the procedures. We also have a compliance committee, chaired by Carroll, which receives periodic reports from each of the people responsible for maintaining an area of the compliance programme.

Archibald: I chair that committee and it also includes members from each of our three investment platforms. What we have been doing is making sure that the policies and procedures that we’ve set out in our manuals are actually being implemented. One issue that comes up regularly concerns restricted securities and insider trading. We maintain a list of securities that our employees are restricted from trading. Having investment professionals on the upper tier compliance committee is very helpful in getting information to update the restricted securities list. Those lists are updated at least quarterly and perhaps more often to make sure that we’ve covered all of the bases where people might be trading. All of our employees have signed documents promising that they will not trade in any restricted securities. We receive and review all of their brokerage statements for compliance purposes. 

Other than that, what the committee does is make sure that what we say we’re doing we are doing by asking a lot of questions. We have the external auditors come and present their analysis of audit risks, procedures and findings.

Jensen: I’d imagine there are many private equity firms in the world looking at the prospect of becoming subject to more regulation – it’s not just a matter of hiring a compliance officer and asking the compliance officer to run out and achieve compliance. In the end, compliance obligations really touch upon the lives of everybody in the firm. Before, where you had informal procedures for fund management activities, like the way you communicate to investors, suddenly you have to create formal procedures with compliance requirements addressed within them. Everything we do – fundraising, even personal trading – is now affected by regulations.

Jensen: We’re already an investment adviser, so probably the threat of the pending US legislation is less of an issue for us. Some of the US compliance requirements will probably increase for us. For instance, today our regulatory reporting includes a great deal of information about our activities as a firm but little information about the funds we manage. It appears that proposed regulatory changes would require us to also submit information on our funds that wasn’t required before. But as I read the requirements, it doesn’t seem to be that onerous once you have a process set up, sort of a profile of your fund. I don’t lose any sleep at night over pending US regulatory changes. 

I’m more concerned with the EU directives that are coming out. Recent reports have described the current EU proposals as creating both a fortress and a prison in the private equity world that would keep EU fund managers from operating outside the EU, and make it very difficult for non-EU firms to operate within the EU. This creates a big concern for firms like ours that invest and service investors globally. But I think there’s quite a bit of interest in the European community to influence the directive. Recently, EU pension plans have been quoted as saying “This is really a barrier to us being effective at investment and it’s going to lower our returns.”

Archibald: One of the points that is raised with the EU directive is that if your own county’s regulations are as robust as what the EU is looking for, then there may be a slightly easier route. But the EU regulators come right out and say that the SEC’s regulations are not sufficient. My reaction is that I think that there are still some things the directive is probably going to require, at least in its current version, that the SEC does not and does not seem likely to require. Some of the things that you might see in the SAS 70 assessment that are not SEC requirements, but are best practices, are some of the things you might see in the directive. 

I think Phil’s point about the ones to speak up being the pension funds is a critical piece of that particular legislation. Private equity sponsors may raise objections, but I think there is only going to be someone listening if it’s a European pension fund who’s saying “You’re limiting my ability to invest, therefore you’re increasing my risk to investing only in Europe rather than investing globally.”

Jensen: I don’t know if you’ll ever marry the two approaches between the SEC’s registered investment adviser requirement and what’s being proposed in the EU. The EU proposals are designed for fund managers. The US Registered Investment Adviser regulations are really written for investment advisers, and it is sometimes a challenge to interpret how they apply to an investment fund manager. This may be one reason it is difficult for the EU to consider the SEC investment advisor regulations to be their equivalent.

Archibald: If the plan passes, there’s a three-year phase-in for non-European fund sponsors. But there’s a gray area: because there’s a three-year phase-in, as they try to work out the pieces, we could market to European investors, but could a European investor actually invest? 

What we’ve been doing is trying to understand the moving pieces. For example, the EU’s custody rules are much more stringent than US custody rules. For a private equity fund, particularly on the fund of funds side where you don’t have a large amount of stock, our securities are usually all in brokerage accounts anyway. So I think it’s more documentation of some of the pieces and parts regarding the custody arrangements. So, if you start now and start to work toward them, you’re already beginning to see what it would take to comply.

Jensen: We’ve looked at the preliminary provisions and how they could have an impact on our lives. At the same time, it appears that the proposals may undergo significant change before they are final. Recently, there has been a response addressing many of the industry’s concerns about the original draft. I’m interested in seeing what shakes out of that process because, at this point, it seems like we would be building contingency plans around something that may or may not move forward in its current form. 

Jensen: Luckily, we don’t depend heavily on placement agents. We’ve used placement agents in limited situations in the past. We don’t expect that this will affect day-to-day lives so much.

Jensen: Like most in the industry, we would prefer that the legislation not go through and we believe it is inconsistent with the basic principles of partnership taxation. It remains to be seen what impact this will ultimately have on the industry.

 

Jensen: It’s not uncommon to have terms in an arrangement that may change a term contingent on future changes to tax law, but we haven’t seen it with respect to the carried interest provision.